For most of the 18th-20th centuries, government bonds usually behaved like a risky asset. When equity prices fell, bond yields rose, i.e. bond and equity returns were positively correlated (bond prices move inversely to yields). But since the mid-2000s, bond and equity returns have been negatively correlated, i.e. bonds became a hedge for risk. Before this, the last time this correlation was near zero for a prolonged period was the long depression in the late 19th century.

At the same time, there has been a structural increase in demand for ‘safe assets’, with more investors demanding safe government bonds for reasons unrelated to their expected cashflows. This has been exacerbated during and since the financial crisis, with deterioration in risk sentiment leading to episodic ‘flight to safety’. And the addition of QE and forward guidance to the monetary policy toolbox may mean long-term bonds react differently to previously.

Bank Underground is a blog for Bank of England staff to share views that challenge – or support – prevailing policy orthodoxies. The views expressed here are those of the authors, and are not necessarily those of the Bank of England, or its policy committees.

3 responses to “Bitesize: 250 years of the bond-equity correlation”

This doesn’t make sense, to me.
Stocks and bonds are both up tremendously since 2009.
Seems like they are highly correlated for the last 7 years, other than during the brief flights to bonds (during stock market corrections).

Maybe it depends how you define risky? Any 1960/1970 (even 1980) will tell you bonds are the natural investment of Pension Funds and Insurance Companies. It was the “cult of the equity” that changed this thinking ( and ultimately fuelled the dot com boom). So maybe the millennium crash in equities relative to bonds is not a change in nature of bonds – but equities going from a non risky asset ( equities always beat bonds in the long term) to a much more risky asset class now. Bonds still do what they always do – pay out when you want them and this is clearly valued at this time

Really good graph though !!

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Bank Underground is a blog for Bank of England staff to share views that challenge – or support – prevailing policy orthodoxies. The views expressed here are those of the authors, and are not necessarily those of the Bank of England or its policy committees.

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